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Citi's TARP Payback Could Cheer Institutional Investors

NEW YORK -- The government's expected exit from
Citigroup Inc.
C 1.23%
could trigger the re-entry of institutional investors like mutual and pension funds.

Institutional ownership in Citi is roughly 20%, the bank calculates. That makes Citigroup "one of the least owned banks" by institutional investors such as mutual funds and pension funds,
J.P. Morgan Chase
JPM 0.67%
& Co. analyst Vivek Juneja wrote in a research report. Normally, institutions hold 70% or more of large companies' shares.

David Trone, an analyst with Macquarie Capital, whose firm's customers are institutional investors, says, "A lot of clients I talk to are afraid" of the government ownership.

Should those investors lose their fear -- and should index funds, for technical reasons, start buying more Citigroup stock -- the shares could rise, offsetting downward pressure of the dilution expected when Citigroup issues some large amount of stock as part of its exit from the government's Troubled Asset Relief Plan investment. Some hedge funds appear to have positioned themselves long in Citigroup's common stock to benefit.

The U.S. government continues to own $20 billion in Citi trust preferred securities, which the company wants to buy back. The government converted other preferred stock into a 34% stake in Citigroup common stock, which the government is expected to sell to investors.

Citi's stock price has been on a slow descent since it last exceeded $5 in October; it fell below $4 Tuesday. In Thursday trading, the stock was up a penny at $3.87.

As of Sept. 30, big institutional investor Fidelity Management & Research controlled 5.1% of
Wells Fargo
WFC 0.80%
& Co. and 2.9% of
Bank of America Corp.
BAC 1.02%
, but only 0.2% of Citi, a stock that used to be a staple of mutual funds. Wellington Management was the seventh-largest holder of Wells Fargo, controlling 1.1% of the San Francisco bank's stock, and 1% of Bank of America; it is not among the top 20 investors of Citi, according to FactSet.

Also on Sept. 30, several well-known hedge fund managers owned large chunks of Citigroup stock.
John Paulson's
Paulson & Co. bought 300 million Citi shares during the third quarter, while
David Tepper's
Appaloosa Management bought 79.7 million and
Lee Ainslie's
Maverick Capital bought 42.4 million. Both purchases were new positions, according to the filings.

Weighing against these hopes is the likelihood of dilution.

Earlier this year, the Federal Reserve said any bank that seeks to repay TARP would have to demonstrate that it can raise equity, and nongovernment guaranteed debt. Investors expect Citi to be required to raise some capital, and at least some in the form of equity. The bank is negotiating with the government and its regulators to determine the amount of capital it needs to raise.

J.P. Morgan's Mr. Juneja wrote in his note that a $10 billion common stock raise would be 6% dilutive to current owners, and combined with a sale of a part of the government's stake, "could pressure the stock price initially."

Citi's current stock price reflects some expectations of dilution, but, Mr. Trone said, "the market is not discounting a full $20 billion" issue of equity capital.

The positive impact on Citi's stock of a government exit would be even more substantial if the Treasury Department sold its common shares. That's because those shares are not counted as part of the bank's capitalization by indexes such as the Standard & Poor's 500, Mr. Trone said. As those shares go from government to private hands, lead index funds would automatically increase their holdings.